China as the World’s Largest Economy: What Does it Mean?

The news that China will displace the U.S. as the world’s largest economy this year is big news. For economists who follow these measurements, the tectonic shift likely occurred a few years ago. But now the World Bank is making it official, so journalists and others who opine on world affairs will have to take this into account. And if they do so, they will find that this is a very big deal indeed.

What does it mean? First, the technicalities: the comparison is made on a purchasing power parity (PPP) basis, which means that it takes into account the differing prices in the two countries. So, if a dollar is worth 6.3 renminbi today on the foreign exchange market, it may be that 6.3 renminbi can buy a lot more in China than one dollar can buy in the U.S. The PPP comparison adjusts for that; that is why China’s economy is much bigger than the measure that you have most commonly seen in the media, which simply converts China’s GDP to dollars at the official exchange rate.

The PPP measure is a better comparison for many purposes. For example, take military spending: the money that China needs to build a fighter jet or pay military personnel is a lot less than the equivalent in dollars that the U.S. has to pay for the same goods and services. This means that China has a bigger economy than that of the U.S., for purposes of military spending. And in a decade, the Chinese economy will most likely be about 60 percent bigger than the U.S. economy.

President Obama has just returned from a trip to Asia where he was criticized for not being “tougher” with China. However, Americans may want to consider whether “containing” China with a “pivot” to Asia is an affordable proposition. When the U.S. had an arms race with the Soviet Union, the Soviet economy was maybe one-quarter the size of ours. We have not experienced an arms race with a country whose economy is bigger than ours, and whose economic size advantage is growing rapidly. Are Americans prepared to give up Social Security or Medicare in order to maintain U.S. military supremacy in Asia? To ask this question is to answer it.

Fortunately, such an arms race is not necessary. China is a rising power, but the government does not seem to be interested in building an empire. Unlike the United States, which has hundreds of military bases throughout the globe, China doesn’t have any. The Chinese government seems to be very focused on economic growth; trying to become a developed country as soon as it can. Since China has 1.3 billion people, having an economy the size of the U.S. means that average living standards are less than one-fourth of ours. They have a long way to go to become a rich country.

Of course, just because an arms race is unnecessary or unwinnable doesn’t mean it can’t get started. The Washington foreign policy establishment is much accustomed to the authority, prestige, and privilege of being the overwhelmingly dominant power on the planet. And as we saw during the eastward expansion of NATO in the 1990s – now coming back to haunt us in a new Cold War with Russia – there are politically powerful military contractors that can also have a voice in U.S. foreign and military policy.

The American people, according to polling data, are of another point of view. They are largely tired of unnecessary wars and mostly sympathetic to President Obama’s response to critics while in the Philippines: “Why is it that everybody is so eager to use military force, after we’ve just gone through a decade of war at enormous cost to our troops and to our budget?” he asked. It is arguable that the only reason our government is able to maintain an imperial foreign policy is that so few Americans serve in the military and pay the ultimate price for it.

Still, there is a powerful ideology of American exceptionalism and a widespread belief that if the United States does not run the world, somebody worse – possibly China – will. The fact that the U.S. and its European allies still have more democratic societies with more developed rule of law than most middle-income countries – despite the setbacks of the past decade – reinforces this notion that the world will be worse off if the U.S. loses power and influence.

But the U.S. lost most of its influence in Latin America over the past 15 years, and the region has done quite well, with a sharp reduction in poverty for the first time in decades. The Washington-based International Monetary Fund has also lost most of its influence over the middle-income countries of the world, and these have also done remarkably better in the 2000s.

In the 18th century, those who opposed democratic revolutions like that of the United States had dystopian visions of governance without monarchy. So, too, our foreign policy establishment cannot imagine a multi-polar world where the U.S. and its allies must negotiate more and give orders less often. But economic trends are making this reality inevitable, and Americans should embrace it. Whatever the internal political systems of the countries whose representation in the international arena will increase, the end result is likely to be more democratic governance at the international level, with a greater rule of international law, fewer wars, and more social and economic progress.